Moody’s Downgrades China’s Rating, Bleak Expectations Follow

China’s rating suddenly dropping goes hand in hand with a negative outlook.

Moody’s Investors Service today significantly lowered China’s long term local currency and foreign currency issuer ratings from Aa3 to A1, which means a change in outlook from stable to negative. The downgrade is a reflection of Moody’s expectation that the country’s financial strength will weaken in the next few years, following a continuously rising economy-wide debt and a slowing down of potential growth.

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Though progressing reforms are likely to change the economy and financial system over time, they might not stop rising debt or the consequent growth in contingent liabilities for the government, according the agency. In addition, Moody’s expressed that despite the decline, at an A1 rating level the risks can still be balanced. The Chinese credit profile, for example, is expected to weaken, but the damage is an obstacle that China can overcome in time.

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Market and Ministry Responses

As can be expected, the Chinese Ministry of Finance and sources within the financial markets worldwide were quick to respond to the change in status.

The ministry stated that it is rejecting Moody’s decision to downgrade its credit rating, claiming that the organization used an “inappropriate” method to assess the risks facing the world’s number two economy. “It over-estimated the difficulties that the Chinese economy is facing,” it said in a statement.

David Cheetham, XTB, said: “The first downgrade to China from Moody’s in almost 30 years has caught the attention of traders this morning as the almost forgotten narrative of a slowdown in economic activity in the Far East could be set to return. The latter parts of 2015 and early 2016 were dominated by growing concerns surrounding the state of the world’s second largest economy as fears of a hard landing in China soured global risk sentiment. Since then however, this theme has been largely overlooked as political shocks in the UK and US – as well as the absence of a political shock in France – have been the main driving factors for markets.”

Peter Rosenstreich, Swissquote Bank, commented: “While the credit rating cuts failed to hurt China’s stock markets, AUD headed lower following industrial commodities weakness and risk in China. In our view the probability of a full blown collapse is low considering their ability to control capital flows. However, today’s rating move is another warning shot from the markets that pace of credit growth and sustainably of debt is worrying. It is uncertain whether China authorities have the nerve to tighten further at the risk of damaging already weak economic growth.”

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